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Straight Talk: The iPhone 5 Test, And What it Tells Us About the American Dream

Friday last week saw the frenzy of the new iPhone 5 launch. The good folk of the United States and the rest of the world jammed into Apple stores to procure their first edition of the latest and greatest gadget. Preliminary numbers indicate that about 5 million phones were sold through the 1st weekend, but we know that Apple recorded 2 million pre-orders, and various blogs including that Limousine Liberal, the Huffington Post, reported many Apple stores sold out of their stock of the new gizmo. Finally, Piper Jaffray Analyst Gene Munster’s projection that Apple will sell 6-10 million iPhone 5 between September 21st and the end of the month, seems like a soft touch given the opening weekend!

I’m no tech analyst, but I am a student of economics; an investor by profession, and a concerned U.S. Citizen. So I was struck by the strongly positive sales emerging from Apple, amid economic data that revealed a U.S. Economy recovering in fits and starts, unemployment stuck above 8%; the first anniversary of the “Occupy Wall Street” movement; and liquid-hot rhetoric spewing from the upcoming elections around the need to represent all Americans.

All Americans, whose right it is to fulfill their “American Dream”. A dream best described by First Lady Michelle Obama in her speech to the Democratic Convention, “that fundamental American promise that, even if you don’t start out with much, if you work hard and do what you’re supposed to do, then you should be able to build a decent life for yourself and an even better life for your kids and grandkids.” Beautifully put indeed. If only I could have jumped in with a question at the end of that statement:

How are you supposed to fulfill your American dream? “with savings or debt?”

And that’s the point isn’t it? Do you build a house of cards, on credit and debt, or a solid house from savings? Because the one is an illusion; the other a dream fulfilled.

So that brings me to the iPhone 5 test. It’s just a set of 3 questions:

Question 1 : Did you buy the latest iPhone 5?

Question 2: If you bought the iPhone 5, how did you pay for it? With cash or with your credit card?

Question 3: If you bought the iPhone 5, and paid with your credit card, do you carry a balance on your credit card?

If your answer is YES to Question 3, then my question to you is:

“Why did you buy the iPhone 5 if you can’t afford it?”

Is this the American Dream? To consume what you can’t afford? Because buying on credit, unless you pay off your card balance every month, is exactly that, living beyond your means. According to the Federal Reserve Historical Statistics, Consumer Credit Card Debt (also called revolving debt) as a % of GDP went up from 1.5% in January 1968, to 5.2% of Nominal GDP in March 2012. Doesn’t seem like much? Consider this, Consumer credit card debt rose at a 16.7% compounded annual growth rate (it rose every year by almost 17%) for the last 43 years, versus GDP (total US income) which grew at 7% per year for the same period. Ever met someone who could grow their debts faster than their income, and sustain it for any period of time?

Is it now a constitutional right to live beyond your means?

I came across a survey undertaken in early 2012 by the Think TankDemos. While I might not agree with many of its conclusions and recommendations, one must acknowledge the excellent work it does in identifying key causes for consumer credit card debt especially among low and middle-income earners. You can find the survey here. Much as I respect this organization’s hard work in collating this report, I was stunned by the very first sentence of its report, “For Americans, the ability to borrow, is the ability to grow”. Debt is certainly an important tool in a family’s tool-kit. But where is the basic tenet, “size yourself for what you can afford?”. It is a simple rule that separates survivors from bankrupt have-beens in the business world. And if a family is having to put basic living expenses on revolving debt, on a sustained basis, then is the answer that public policy should make debt easier to service and default on? Or is it that individuals need to re-consider their standard of living? The last I heard, you spent what you could afford, and if you had some big project you might need to spend on like a critical operation, or the purchase of a car, house or a special vacation you saved for it, and you cut back on as much else as you could. And if the family had to do without things they desired they just did. Parents said, “no”, when I was growing up. They also said, “we don’t need this to be happy”.

Tax policy is a fair debate to have. But it has to be had concurrent with a debate about the American addiction to spending and debt. When will those who tout themselves leaders of All Americans, stand up and say it straight to the American people? When will Senator Carl Levin call for special hearings on “Consumer Negligence of their Personal Finances, and the Need for Consumers to Take Personal Responsibility for their Fiscal Condition”? When will President Obama, every time he talks about the rich paying their “fair” share of taxes, also ask all middle class families to look at their checkbooks first?

We as a nation are more indebted than we have ever been in the past – individually, and collectively. And it is not just because of the bail-outs of the Financial, and Auto sectors, or the “stimulus” money spent in 2008-09. We are addicted to a system that favors borrowing and spending, on easy credit, to drive economic growth. And that’s fine, so long as you make sure you can service both the principal and the interest payments that are inevitable. Check out my analysis here. This table compares U.S. Indebtedness to that of the Eurozone. AARP mightn’t care about our own looming debt crisis, but anyone who is less than 55 years of age, cannot afford to depend on there being any social security dollars to fund our retirement. We have to tighten our belts and make smart spending decisions, and save more. Retailers, Entertainers and Apple mightn’t like it either, but as a nation we have no other choice. And Don’t laugh. The only difference between us and Greece, is that we can borrow at 1.8%, and they can’t borrow even at 20%. And if you’re now rolling on the ground at my audacity, consider this: Greece was paying 3.2% during the heyday of Eurozone debt financing in 2006, not much above our current rate.

The irony of the iPhone 5 test is, of course, that iPhone owners tend to be more affluent than the average smartphone user. According to one poll I found, 60%+ of iPhone users, versus, 36% of Android users, report incomes above $75,000, annually. So if you bought the iPhone 5, it is less likely you carry a balance on your credit card. I could call it the Samsung S3 test I suppose to better effect. Keep in mind they both cost roughly the same at the intro level, which at $199.99 is not chump-change (excluding the fixed cost of a 2-year contract).

So before we join the drum-roll for higher taxes on the rich, and the unfairness of the American economic system, let’s all step back and look at our own finances. What are we doing that’s smart or not about our personal money decisions? Wealth and success are not constitutional rights. Even having a job isn’t. The government can try to help you along. But all that you can ask for is the right to try, and that we be given a lawful, free, non-discriminatory environment in which to do so. We can’t ask any more than that, until we’ve asked more of ourselves!

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I bought them with a credit card because of the benefits of reward points , extended warranty + loss protection of 6 months.

I will most likely carry the balance over 2-3 months at 9% APR which will end up costing me a net of around $20 on financing of 3 iPhones. Well worth it to me.

What might not be worth it is the cost of the subsidy of the phone by the carrier but we use the phones as a business tool and the functionality is worth the extra cost. In fact, the lower cost of apps and software of the iPhone replaced thousands of dollars in software expenses we had previously purchased.

While I agree with much of what you wrote, especially the underlying dangers of credit card use to live beyond one’s means. Nevertheless, I can’t agree that buying things on credit, in and of itself, is equal to living beyond one’s means as you state. Credit is a necessity of life. Are you saying none of us should own a home or buy a car unless we have all of the funds to pay it off? One’s means is not simply defined as what one has in their bank account at any point in time, it also must include the future earnings power that person possesses.

I’d agree that anyone who buys an iphone on credit with no real means to pay off that debt is likely making a financially irresponsible decision. However, if you are more disciplined in your financial life and have a steady job that will allow you to pay off the price of the device in due time, then you should be free to do so.

The value of something is not simply the price you pay for it but the utility it provides over the course of its use. For some, it’s worth buying an iphone on credit and forgoing other future purchases in order to pay this down, especially if it improves their quality of life more than the cost that person bears to purchase it. That’s not being irresponsible. In fact, I’d argue that it’s the opposite.

Hey Taesik: Thanks for your comment. There are a couple points worth making here:

a. If you will recall, in my post, I said if one is buying stuff on credit and NOT paying off the balance at the end of the month, then that IS in my view living beyond my means. I cannot see any purchase that is valuable enough to justify paying 18% per year interest, other than reckless disregard for one’s own financial health. For sure if i buy a washer from Sears (when they did this kind of stuff) applied for a sears card and got an interest free period, then again, you make sure you pay off the credit card balance BEFORE the interest gets accrued. It’s simple fiscal discipline.

b. We do use debt to finance large acqns like a house or a car. But earnings power? In my opinion, this is not an equity analysis that is assessing my future earnings power. This is a debt calculation and i buy today what i know i can service from TODAY’s cash flow. Maybe grow it a bit? But this is not a growth investment decision.

c. Presence of a steady job, has nothing to do with a debt decision, although absence of a job should stop one at the door of the shop for sure! No business would undertake an 18% loan to finance ANYTHING unless they were in a financial crisis of the magnitude we saw in 2008-09. To undertake such a debt when you have a steady job? Why not just flush money down the drain? It’s a free world for sure, and everyone has a right to make whatever fiscal decisions they want to. I am part of the top 10% that contributes 86% of all federal income tax dollars that pays for this country’s entitlement and discretionary spending. I resent a middle class voter, who is taking on 18% credit card debt to pay for an iPhone saying that it’s time I paid my “fair” share of taxes…and the same goes for the President’s comments. When did Prez Obama ever, in one of his various stump stops, also exhort his voters to be fiscally responsible in their spending habits? Of course he is a politician!

d. Quality of life should be determined not by possessions we own. I’m a fiscal conservative, but even i agree with Mrs. Obama’s exhortation in her speech, that success cannot be measured in money terms. It should be determined by the impact we have on our community and society. But I can’t expect to live like someone 10x richer than me simply by using credit. The message that it’s ok to spend big because you dream big is what’s gotten most of the developed world into the fiscal mess we are in today!

Of course the presence of a steady job factors into debt decisions. In fact, the expectation of future income earned factors into every purchase decision we make. Think of it this way. Even if you have the money right now to buy a iphone, would your decision to do so change knowing that you will lose your job six months from now? Probably. Because consumer purchasing decisions are not simply a function of what they currently have. It’s also a function of what they know they will have.

And by earnings power, I mean exactly what you do. I think you’re confusing earnings power with earnings potential. By the former I mean what I currently generate. What I expect to receive from my next paycheck. The latter refers to what I think I can make ten years from now. I was referring to the former. Responsible credit decisions should be made based on the the former. Mortgage payments should be based on what you can afford currently, not what think you can afford later. But that was my point. If a person can buy something on credit that can be serviced from their current income cash flow even it takes more than month to do so, I see nothing wrong with that. You seem to only see the extremes — you should only buy things you can pay for outright, you should never buy anything you can’t pay for within a month. What if your current cash flow allows you to pay for it in six months or two?

You’re the not only one that’s part of the top 10%. I am too. But I don’t blame everyone with credit card debt as the reason for this countries ills. How can I when the millions of folks that service their debt month in, month out actually helps contribute to economic growth.

Thanks for your thoughtful response Taesik. Also thanks for the clarification on point (b).

However, we will have to agree to disagree on the point of servicing debt for operating expenses. My point is that an individual is not a business. A business gives credit and needs credit to run itself. It does so with working capital. Then capex is funded through appropriate debt issue/bank loans. For an individual, the concept of creating revolver debt to mirror “working capital credit” was just one of the many fallacious innovations that has become regular behavior now. I do understand a situation when a financial crisis in a family causes credit card debt to be taken on. I recall a time when my dad had to fund a life saving op for my grand-dad (his father in law). no such thing as medicare where i lived, and the family took on credit card debt to pay for that op. and then we paid it down. But fundamentally, in my humble opinion, there is no cause to take on working capital debt as a household. i don’t undertake receivables if i am a salary earner, and i have no business undertaking gratuitous payables to finance a lifestyle. I do, as an individual, take on some long term debt – mortgages etc. – to fund some capital purchases like a house.

There is a reason that the interest rate is so high on credit card debt. becasue the defaults are so high! and we’ve accepted that as a fait accompli of our current lifestyle. that’s what is so wrong! Finally, economic growth that is fuelled by such debt-financed expenditure is the very mirage that I’m talking about in my article. It isn’t real value added to the economy at all. not in the long run anyway. The only real growth it is fueling is GDP growth in China, where the jobs are created and the products manufactured that we buy. I ask you to consider the point i am making. but of course we can agree to disagree. It is distressing though, for me to think, that we all accept revolving debt as a natural state of being for individuals. It was a necessary innovation for businesses, a fallacious innovation for individuals. Case rested, and the floor is yours now :)

I think what Chitra is talking about is about responsibility of the person taking any debt to buy a lifestyle enabling products like the iPhone 5, towards self and the society in large. It is a fair question! The second aspect she seems to highlight, which I agree with, is the atmosphere of acceptability to take on debt beyond ones means – to finance anything from a house to a gadget. Sub-prime crisis in a way is a good example for this and buying an iPhone 5 using a credit card paying high interest rates falls in the same bracket.

Is it not better if people started saving to buy stuff they desire? If they have to buy through debt, say a house, is it not better to do that only when they are sure they will have the income and a job for the foreseeable future to repay it without killing themselves?

I disagree that buying anything can better ones quality of life. Of course mine is a puritanical view which believes we don’t need material things to be more happy. This might not be how someone like you who is in the top 10% thinks, but if your attitude is adopted by those who are not so well off, the society will implode below the huge burden of non-serviceable debt.